Microfinance rating

F inancial transparency is about the production, testing, dissemination and use of information related to an MFI's financial performance. Beginning with an MFI gathering and reporting accurate information, the sequence extends to verifying the information, then to analyzing, comparing, and judging the performance described by that information, and finally to supervising the MFI to ensure that it complies with applicable standards.

ACCION CAMEL Founded in 1961, ACCION International aims to reduce poverty in North and South America by providing small loans through its affiliates in 15 Latin American countries, 4 African countries, and 29 U.S. cities.

The CAMEL methodology was originally adopted by North American bank regulators to evaluate the financial and managerial soundness of U.S. commercial lending institutions. The CAMEL reviews and rates five areas of financial and managerial performance:

Based on the conceptual framework of the original CAMEL, ACCION International developed its own instrument. Although the ACCION CAMEL reviews the same five areas as the original CAMEL, the indicators and ratings used by ACCION reflect the unique challenges and conditions facing the microfinance industry. To date, ACCION has used its CAMEL primarily as an internal assessment tool, which has contributed to setting performance standards both for the ACCION Network and for the microfinance industry as a whole.

North American bank regulators adopted the original CAMEL methodology to evaluate U.S. commercial lending institutions. Based on that methodology, ACCION developed its own instrument in 1993 to evaluate MFI performance.

The MFI is required to gather the following information for a CAMEL examination:

(1) financial statements;

(2) budgets and cash flow projections;

(3) portfolio aging schedules;

(4) funding sources;

(5) information about the board of directors;

(6) operations/staffing; and

(7) macroeconomic information.

CAMEL is the acronym for five key aspects of an MFI's performance: Capital adequacy, Asset quality, and Management, Earnings, and Liquidity management. While the ACCION CAMEL issues a composite score, similar to a rating, it is not meant to measure credit risk. The final score ranges from 0 to 5, or D to AAA.

Eight quantitative indicators account for 47 percent of the rating, and 13 qualitative indicators make up the remaining 53 percent. The final CAMEL composite rating is a number on a scale of zero to five, with five as the measure of excellence. This numerical rating, in turn, corresponds to an alphabetical rating (AAA, AA, A; BBB, BB, B; C; D; and not rated).

Based on the results of the adjusted financial statements and interviews with the MFI's management and staff, a rating of one to five is assigned to each of the CAMEL's 21 indicators and weighted accordingly.

A definition of each area and the criteria ranges for determining each rating are as follows:

Capital adequacy :

Leverage: the relationship between the risk-weighted assets of the MFI and its equity.

Ability to raise equity: assessment of an MFI's ability to

respond to a need to replenish or increase equity at any given time.

Adequacy of reserves: measure of the MFI's loan loss reserve and the degree to which the institution can absorb potential loan losses.

• Infrastructure: -evaluation of whether it meets the needs of both staff and clients

Governance: how well the institution's board of directors functions, including the diversity of its technical expertise, its independence from management, and its ability to make decisions flexibly and effectively.

Human Resources: evaluates whether the department of human resources provides clear guidance and support to operations staff, including recruitment and training of new personnel, incentive systems for personnel, and performance evaluation system.

Information Technology System: assesses whether computerized information systems are operating effectively and efficiently, and are generating reports for management purposes in a timely and accurate manner

Strategic planning and budgeting: whether the institution undertakes a comprehensive and participatory process for generating short- and long-term financial projections and whether the plan is updated as needed and used in the decision-making process.

Information Technology System: assesses whether computerized information systems are operating effectively and efficiently, and are generating reports for management purposes in a timely and accurate manner.

Strategic planning and budgeting: whether the institution undertakes a comprehensive and participatory process for generating short- and long-term financial projections and whether the plan is updated as needed and used in the decision-making process.

Adjusted return on equity: measures the ability of the institution to maintain and increase its net worth through earnings from operations

Operational Efficiency: measures the efficiency of the institution and monitors its progress toward achieving a cost structure that is closer to the level achieved by formal financial institutions.

Adjusted Return an Assets: measures how well the MFI's assets are utilized, or the institution's ability to generate earnings with a given asset base.

Interest rate policy: assess the degree to which management analyzes and adjusts the institution's interest rates on microfinance loans (and deposits if applicable), based on the cost of funds, profitability targets, and macroeconomic environment

Liability structure: review of the composition of the institution's liabilities, including their tenor, interest rate, payment terms, and sensitivity to changes in the macroeconomic environment.

Availability of funds to meet credit demands: measures the degree to which the institution has delivered credit in a timely and agile manner.

Cash flow projections: evaluate the degree to which the institution is successful in projecting its cash flow requirements.

Productivity of other current assets: evaluates extent to which the MFI maximizes the use of its cash, bank accounts, and short-term investments by investing in a timely fashion and at the highest returns, commensurate with its liquidity needs.